United States: Watch the Napkin: First Circuit Affirms Insider-Trading Conviction

In what appears to be the first appellate decision since the
Supreme Court's December 2016 ruling in Salman v. United States, the U.S.
Court of Appeals for the First Circuit affirmed an insider-trading
conviction based on a tip of material, nonpublic information. The
February 24, 2017 decision in United States v. Bray held that the
jury had sufficient evidence to conclude that, in soliciting and
receiving a trading tip surreptitiously written on a pub-room
napkin, the tippee had known that the tipper had provided the
information in breach of his duty of confidentiality and in
expectation of a personal benefit.

However, the court also made clear that a tippee cannot be
criminally convicted for insider trading if he merely "should
have known" of the tipper's breach of duty. The court
further held that a "willful blindness" or
"conscious avoidance" standard cannot be based on mere
negligence (at least in a criminal case).

Factual Background

The Bray case arose out of the
relationship between a bank executive (the tipper) and a contractor
and real-estate developer (the tippee). The two were members of the
same country club and had known each other for 15 years. They often
socialized together at the club and elsewhere. The tippee knew the
tipper's family and had taken "a particular liking"
and provided gifts to the tipper's son. The tipper used some of
the tippee's business associates to refurbish his house, and
the tippee regularly asked the tipper for trading advice about bank
stocks. The tipper routinely answered those questions by providing
advice based solely on public information.

However, on one occasion, the tippee told the tipper that he
(the tippee) needed to make a "big score" to finance a
real-estate project, and he asked the tipper for any "bank
stock tips." The tipper again provided some public
information, but he also wrote the name of a local bank on a napkin
and gave it to the tippee, saying "'[t]his could be a good
one,' or at least 'something to that effect.'"

The tipper knew about the local bank because his employer had
told him to do due diligence on it as a potential acquisition
target, and he had signed an agreement requiring him to keep
confidential any nonpublic information he learned. The tipper did
not "explicitly" tell the tippee about the
confidentiality agreement or the source of his tip. The tippee
later offered the tipper a free stake in the real-estate project
that he had hoped to finance through the "big score."

The tippee placed large trades in the local bank's stock,
which was thinly traded – and which his broker tried to
convince him not to buy in such substantial amounts. Approximately
two weeks later, the tipper's employer announced an agreement
to buy the local bank at almost double the previous day's
closing stock price.

The Government prosecuted the tippee under the misappropriation
theory of insider trading, which posits that individuals (such as
the tipper) who are "entrusted with confidential information
about a corporation cannot secretly us[e] such information for
their personal advantage even when they do not owe any direct
fiduciary duty to [the issuer] or its shareholders." The
tippee's liability is derivative of the tipper's. Tippee
liability "hinges on whether the tipper breached a duty of
trust and confidence by disclosing the inside information, which in
turn depends on whether the tipper personally will benefit,
directly or indirectly, from [the] disclosure." The tippee
inherits the tipper's duty "if the tippee knows the
information was disclosed in breach of the tipper's
duty."

The jury convicted the tippee of insider trading, and the First
Circuit affirmed the conviction, rejecting the tippee's
challenges to the sufficiency of the evidence and holding that the
jury instructions – although erroneous in certain respects
– had not constituted "plain error."

First Circuit's Decision

Sufficiency of the Evidence

The court first held that, based on the evidence at trial, the
jury could have concluded that the tipper had given the inside
information to the tippee with the purpose of obtaining a personal
benefit. Under the Supreme Court's decisions in Dirks v. SEC and Salman v. United States, the
personal-benefit element requires the court to "focus on
objective criteria, i.e., whether the insider receives a
direct or indirect personal benefit from the disclosure, such as a
pecuniary gain or a reputational benefit that will translate into
future earnings." But "a personal benefit can often be
inferred where a relationship between the [tipper] and the
recipient . . . suggests a quid pro quo from the
latter, or an intention to benefit the particular
recipient. . . . A personal benefit can likewise be
inferred where a tipper makes a gift of inside information to a
trading relative or friend."

In this case, the evidence "showed that it is at least
'plausible' that [the tipper] and [the tippee] had a close
relationship." Moreover, the tipper had testified that, in
giving the tip, he had "'figured [the tip] would
enhance' his reputation with [the tippee]." A reasonable
jury could therefore have inferred that the tipper had
"expected a benefit down the road" – and he in fact
received one, when the tippee later offered him a free stake in the
real-estate project.

The court further concluded that a reasonable jury could have
found that the tippee had known that the tipper had tipped him in
expectation of a personal benefit. The pair's "close
relationship" could have led the jury to infer that the tipper
had intended to benefit the tippee, and the tippee's two offers
of a free stake in the real-estate project could have bolstered
that conclusion. A reasonable jury could also have concluded that
the tippee had known of the tipper's breach of his duty of
confidentiality: the tippee had known "what the tipper
did for a living" and had been aware that the tipper had
surreptitiously provided the inside information in response to the
tippee's request for "a 'tip' on which he could
make a 'big score.'"

Jury Instructions

The tippee fared somewhat better with his challenges to the jury
instructions.

First, the appellate court held that the District Court had
"clearly erred" by instructing the jury that it could
convict the tippee if it found that he "'knew or
. . . should have known' that [the tipper] had
breached a duty of confidentiality by giving him the [bank]
tip." A "should have known" standard – which
can be negligence-based – is inconsistent with the state of
mind required for criminal liability.

Second, the First Circuit found clear error in the jury
instruction equating "willful blindness" with negligence.
The willful-blindness standard allows imposition of criminal
liability "on people who, recognizing the likelihood of
wrongdoing, nonetheless consciously refuse to take basic
investigatory steps." A negligence standard is inconsistent
with a requirement of conscious and deliberate avoidance of
knowledge.

However, the First Circuit ultimately affirmed the conviction
despite the erroneous jury instructions because the tippee had not
objected to them at trial and was unable to prevail under the
rigorous "plain error" standard of appellate review.

What the Court Did Not Decide

The Bray decision flagged several
potentially important issues that the court did not
resolve – and that will undoubtedly continue to arise in
insider-trading cases.

First, the First Circuit did not decide whether the
personal-benefit requirement – which was developed in
classical-theory insider-trading cases (involving breaches of duty
by the issuer's insiders) – also applies to
misappropriation-theory cases such as this one. The court saw no
need to resolve the issue because the record contained evidence
that the tipper-misappropriator had expected a personal benefit in
exchange for disclosing material, nonpublic information.

Second, the First Circuit did not decide whether a personal
benefit can be inferred in the absence of a quid pro quo
or some other objective, consequential exchange if the tipper and
the tippee did not share a "meaningfully close
personal relationship." The Supreme Court's Salman decision had not addressed that
issue because the tipper and the initial tippee in that case were
brothers. The First Circuit saw no need to decide that question,
either, because "the record's evidence of [the
tipper's] and [the tippee's] friendship, coupled with [the
tipper's] testimony that the tip might lead to certain future
benefits, provided a sufficient basis for a reasonable jury to
conclude that [the tipper] had acted in expectation of a personal
benefit." This issue – the interconnection (if any)
between the nature of the tipper's and the tippee's
personal relationship and the tangibility of the tipper's
personal benefit – will likely remain a battleground in
insider-trading cases.

Third, the First Circuit did not decide whether a tippee must
actually know (at least in a criminal case) that the
tipper disclosed confidential information in exchange for a
personal benefit, or whether some lesser degree of awareness might
suffice. The Supreme Court had expressly declined to address that
issue in Salman, and the parties in Bray had assumed that a knowledge
standard applied. The First Circuit found the issue to be "of
no consequence" because the jury could reasonably have
concluded that the tippee had possessed the requisite knowledge
even under the most stringent standard.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here

If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you
are granted a non-exclusive, revocable license to access the Website under its
terms and conditions of use. Your use of the Website constitutes your agreement
to the following terms and conditions of use. Mondaq Ltd may terminate your use
of the Website if you are in breach of these terms and conditions or if Mondaq
Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to
read the full text of the content and articles available (the Content). You may
not modify, publish, transmit, transfer or sell, reproduce, create derivative
works from, distribute, perform, link, display, or in any way exploit any of the
Content, in whole or in part, except as expressly permitted in these terms &
conditions or with the prior written consent of Mondaq Ltd. You may not use
electronic or other means to extract details or information about Mondaq.com’s
content, users or contributors in order to offer them any services or products
which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the
suitability of the information contained in the documents and related graphics
published on this server for any purpose. All such documents and related
graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or
its respective suppliers hereby disclaim all warranties and conditions with
regard to this information, including all implied warranties and conditions of
merchantability, fitness for a particular purpose, title and non-infringement.
In no event shall Mondaq Ltd and/or its respective suppliers be liable for any
special, indirect or consequential damages or any damages whatsoever resulting
from loss of use, data or profits, whether in an action of contract, negligence
or other tortious action, arising out of or in connection with the use or
performance of information available from this server.

The documents and related graphics published on this server could include
technical inaccuracies or typographical errors. Changes are periodically added
to the information herein. Mondaq Ltd and/or its respective suppliers may make
improvements and/or changes in the product(s) and/or the program(s) described
herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally
identifies you, including what sort of information you are interested in, for
three primary purposes:

To allow you to personalize the Mondaq websites you are visiting.

To enable features such as password reminder, newsletter alerts, email a
colleague, and linking from Mondaq (and its affiliate sites) to your website.

Mondaq (and its affiliate sites) do not sell or provide your details to third
parties other than information providers. The reason we provide our information
providers with this information is so that they can measure the response their
articles are receiving and provide you with information about their products and
services.

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to
view the free information on the site. We also collect information from our
users at several different points on the websites: this is so that we can
customise the sites according to individual usage, provide 'session-aware'
functionality, and ensure that content is acquired and developed appropriately.
This gives us an overall picture of our user profiles, which in turn shows to
our Editorial Contributors the type of person they are reaching by posting
articles on Mondaq (and its affiliate sites) – meaning more free content for
registered users.

We are only able to provide the material on the Mondaq (and its affiliate
sites) site free to site visitors because we can pass on information about the
pages that users are viewing and the personal information users provide to us
(e.g. email addresses) to reputable contributing firms such as law firms who
author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us
not to disclose your details to any of these parties, please tick the box above
or tick the box marked "Opt out of Registration Information Disclosure" on the
Your Profile page. We and our author organisations may only contact you via
email or other means if you allow us to do so. Users can opt out of contact when
they register on the site, or send an email to unsubscribe@mondaq.com with “no
disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate
registration form. This is a personalised service where users choose regions and
topics of interest and we send it only to those users who have requested it.
Users can stop receiving these Alerts by going to the Mondaq News Alerts page
and deselecting all interest areas. In the same way users can amend their
personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an
identifying user number. The cookies do not contain any personal information
about users. We use the cookie so users do not have to log in every time they
use the service and the cookie will automatically expire if you do not visit the
Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to
personalise a user's experience of the site (for example to show information
specific to a user's region). As the Mondaq sites are fully personalised and
cookies are essential to its core technology the site will function
unpredictably with browsers that do not support cookies - or where cookies are
disabled (in these circumstances we advise you to attempt to locate the
information you require elsewhere on the web). However if you are concerned
about the presence of a Mondaq cookie on your machine you can also choose to
expire the cookie immediately (remove it) by selecting the 'Log Off' menu option
as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example,
advertisers). However, we have no access to or control over these cookies and we
are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement,
and gather broad demographic information for aggregate use. IP addresses are not
linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or
its affiliate sites) are not responsible for the privacy practices of such other
sites. We encourage our users to be aware when they leave our site and to read
the privacy statements of these third party sites. This privacy statement
applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or
contests. Participation in these surveys or contests is completely voluntary and
the user therefore has a choice whether or not to disclose any information
requested. Information requested may include contact information (such as name
and delivery address), and demographic information (such as postcode, age
level). Contact information will be used to notify the winners and award prizes.
Survey information will be used for purposes of monitoring or improving the
functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our
site, we ask them for the friend’s name and email address. Mondaq stores this
information and may contact the friend to invite them to register with Mondaq,
but they will not be contacted more than once. The friend may contact Mondaq to
request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’
information. When users submit sensitive information via the website, your
information is protected using firewalls and other security technology. If you
have any questions about the security at our website, you can send an email to
webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode),
or if a user no longer desires our service, we will endeavour to provide a way
to correct, update or remove that user’s personal data provided to us. This can
usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will
post those changes on our site so our users are always aware of what information
we collect, how we use it, and under what circumstances, if any, we disclose it.
If at any point we decide to use personally identifiable information in a manner
different from that stated at the time it was collected, we will notify users by
way of an email. Users will have a choice as to whether or not we use their
information in this different manner. We will use information in accordance with
the privacy policy under which the information was collected.

How to contact Mondaq

If for some reason you believe Mondaq Ltd. has not adhered to these
principles, please notify us by e-mail at problems@mondaq.com and we will use
commercially reasonable efforts to determine and correct the problem promptly.

By clicking Register you state you have read and agree to our Terms and Conditions